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Tuesday, January 4, 2011

Lessons Unlearned - Facebook & Goldman Sachs

Back in the spring of 2010 there was a brief uproar about the obtuse nature of privacy settings on Facebook. In the face of the uproar, Facebook made some changes and Mark Zuckerberg had an op-ed in The Washington Post. Mr. Zuckerberg said this:

"If we give people control over what they share, they will want to share more. If people share more, the world will become more open and connected. And a world that's more open and connected is a better world. These are still our core principles today."

Apparently when Mr. Zuckerberg advocated for openness and sharing, he didn't count Facebook in that number. Recent reports from The New York Times outline how Facebook has partnered with Goldman Sachs to market a financial product intending to raise capital for Facebook. Here's the rub, since Goldman is marketing the product it is made to look like Goldman is a single investor, instead of counting all those individuals that got this exclusive offer. Why do that? Because if you have more then 499 investors you have to disclose your financial results. I guess sharing isn't so grand but control is.

So let's consider some obvious parts to this story. First, Mr. Zuckerberg is a hypocrite. He wants to catalog your information and make money off of it, but he really likes to have control and isn't big into sharing how is company is really doing. Second, while this may not be strictly illegal, it would certainly appear to violate the spirit, if not the letter of the law. Did Goldman Sachs really learn so little during the financial crisis?

The SEC is investigating this activity, so we will see what happens with that. I find it incredulous that a finance firm would think this is good business so soon after the crisis. Maybe the problem was so many people got bailed out that lessons went unlearned. Maybe, as Paul Krugman often say, when it comes to high finance, heads they win, tails we lose.

I take some solace in the idea that Facebook probably won't be here in 2036, though I fear populist narcissism and corporate obliqueness will.

8 comments:

So Zuckerberg is a hypocrite and doesn't want to open his books -- big deal. It's his company, he should be able to do as he likes. If you don't like it, don't invest in the company or become a facebook user. Problem solved. Why this is the government's business I haven't a clue.

What's really instructive here is that this appears to be another example of government run amok, with absurd levels of regulation producing unintended consequences. As one of the NYT articles notes:

The buyers in these so-called secondary trading markets are mostly wealthy speculators looking to snag a piece of the next Apple, Microsoft or Google before the rest of the investing public can.

...“We are serving a growing need,” said David Weir, the chief executive of SharesPost, an online marketplace for private investments started last year that now has 39,000 registered members. “A decade ago, these companies would be public by now. Investors can now buy into these businesses and sellers can exit their already valuable stakes.”

So thanks to regulation, these companies are far more reluctant to go public than in the past, with the result that "wealthy speculators" are the only people who can get in on the action while average Joes are left on the sidelines. Spectacular work guys.

Jason, you decry Facebook's violation of the spirit if not the letter of the disclosure law, but why does it even exist in the first place?

The only context in which this regulation makes any sense is if one believes people are too stupid to know how to invest their own money and need big brother to look after them. Sorry, but I'm an adult, and would appreciate being treated as such.

So Zuckerberg is a hypocrite and doesn't want to open his books -- big deal. It's his company, he should be able to do as he likes. If you don't like it, don't invest in the company or become a facebook user. Problem solved. Why this is the government's business I haven't a clue.

What's really instructive here is that this appears to be another example of government run amok, with absurd levels of regulation producing unintended consequences. As one of the NYT articles notes:

The buyers in these so-called secondary trading markets are mostly wealthy speculators looking to snag a piece of the next Apple, Microsoft or Google before the rest of the investing public can.

...“We are serving a growing need,” said David Weir, the chief executive of SharesPost, an online marketplace for private investments started last year that now has 39,000 registered members. “A decade ago, these companies would be public by now. Investors can now buy into these businesses and sellers can exit their already valuable stakes.”

So thanks to regulation, these companies are far more reluctant to go public than in the past, with the result that "wealthy speculators" are the only people who can get in on the action while average Joes are left on the sidelines. Great work guys.

Jason, you decry Facebook's violation of the spirit if not the letter of the disclosure law, but why does it even exist in the first place?

The only context in which this regulation makes any sense is if one believes people are too stupid to know how to invest their own money and need big brother to look after them. Sorry, but I'm an adult, and would appreciate being treated as such.

The issue is the fact that there is a law on the books, right now, and that Goldman Sachs and Facebook are colluding to skirt around it.

It is worth having a debate about the law, its intent, its practical implication, and considering an alternative (which could include a full repeal), but that does not exonerate Goldman Sachs or Facebook of engaging in unethical, if as yet not illegal, activity.

How is it unethical? There is a law, they are following it, what is the problem? You accuse them of breaking the spirit of the law, but what does that mean? Would letting 492 investors in on the deal instead of 499 be in the spirit of the law? 476? What is the magic number?

Furthermore, and perhaps more importantly, why is this important? Who is being hurt here? Why should the SEC or anyone else care?

It's unethical because it's not Goldman's money. It's the money of outside investors, using Goldman Sachs as a portal to gain access. If the number of investors were 125, 346, or 499 then there would be no issue. The "magic" number right now is 499, because that's what the law stipulates. Again, if a debate needs to take place about the law itself, I welcome that. In the interim, though, this is unethical and potentially illegal.

I wonder if people asked the same questions you pose at the end of your comment back in 2006 or 2007 with shadow markets of investment traded billions in assets without proper oversight?

I don't think it's likely, hell not even that probable, that this Goldman/Facebook deal will lead to a market collapse. However, I think it speaks to greater lessons unlearned and could be the precursor of bigger secondary market exchanges that could lead to a (second) market collapse.

In short, it is discouraging that after all we've seen, after all people have suffered, after all the bailouts, bankruptcies, and restructuring that occurred because people tried to work around and not within the regulatory structure that a leading company of finance is so quick to find new ways to make money by going around regulations.

It's unethical because it's not Goldman's money. It's the money of outside investors, using Goldman Sachs as a portal to gain access.

Maybe I am being obtuse, but I fail to see how it makes any difference whether the money belongs to GS or the investors. How do the investors make the transaction unethical? I'll note that neither NYT article raised any ethical concerns (or maybe I didn't read closely enough). Indeed, one of the articles points out that it isn't readily apparent what the SEC is even investigating or why they are doing so.

The "magic" number right now is 499, because that's what the law stipulates.

If a speed limit is 65 mph, is it unethical to drive 64?

I wonder if people asked the same questions you pose at the end of your comment back in 2006 or 2007 with shadow markets of investment traded billions in assets without proper oversight?

We probably would have benefited if more such questions were asked. It is not entirely obvious to me how a crisis originating in arguably the most regulated sector of the economy suggests insufficient levels of regulation and oversight.

More generally, it seems to me you are expressing frustration that people are not operating based on how regulators intended for them to behave and that unintended consequences are cropping up. This, however, is simply another illustration of the folly of the regulatory state.

Upon re-reading this, I think I was being obtuse -- focusing more on the 499 figure than the use of GS as a single investor -- and I apologize for that. The speed limit comment was particularly stupid upon further reflection.

That said, I still would argue that this is hardly a cause for outrage, as under SEC law entities such as hedge funds -- which have multiple investors -- also count as a single entity investor, so the fact that people can do this through GS doesn't strike me as very remarkable. Furthemore, the WSJ describes the intentions behind the 500 investor limit as follows:

The rules require firms with 500 or more shareholders of record in a given type of stock to publicly disclose certain financial information. The requirement is designed to protect investors from risking money on companies that say little about their operations and performance.

Now why it is the job of government to protect investors from making investment decisions based on imperfect information I have no idea. We let people gamble in Vegas with their money, why not on equities? It's their money and their business. I am actually relieved that capitalism has apparently found a way to get around this silly requirement.

Lastly, I don't see this as any danger to the broader financial system. Remember, this is individual investors investing in Facebook via GS. Thus, I don't think we can invoke the dangers of too big to fail here, as those in danger of losing their shirts are individuals rather than institutions.

Your concession on the initial read is appreciated, and I think you capture what irritates me about the GS deal in your most recent comment.

As to your lack of concern for the broader financial system, I don't believe (and I said as much in a previous comment) that this particular deal will create a "too big to fail" situation and it is individual investors.

My contention would be that the size of the assets in play, and not the distinction between individual or institution, that creates the risk of market failure. And while hedge fund managers work without the implied safety net of a government bailout, that does not mean they can't wreak havoc upon the markets. The havoc that they could wreak would likely lead to their own destitution, but it could also lead to the job displacement/destitution of a great many people. That's capitalism, but as a capitalist, I find the role of government in the markets is to take some of that sharp edge off. On this, I think you and I fundamentally disagree.

I also believe, as a capitalist, that transparency leads to greater information which leads to greater market efficiency.